S&P Downgrades See Muted Market Response
Investors are again downgrading the decision-making of Standard & Poor’s.
Less than a week after the New York-based company cut its ratings of nine countries including France, the French 10-year bond is little changed at 3.08 percent and borrowing costs fell this week at the country’s sale of 8.59 billion euros ($11 billion) in bills. Spain, whose rating was lowered by two levels to A, sold debt at half the interest rate of a month ago.
The response was the same last August, when financial markets dismissed the U.S.’s loss of AAA status by pushing the yield on the 10-year Treasury note to a record low of 1.6714 percent just seven weeks later. S&P may be further behind the curve as investor sentiment improves after the European Central Bank twice reduced interest rates and offered banks unlimited cash to support the banking system.
“By the time the ratings agencies get around to doing their paperwork, everyone knows it’s going to happen, so the market moves faster and prices everything,” said Carl Weinberg, chief economist and founder of High Frequency Economics Ltd. in Valhalla, New York. “We’ve seen no bump in Europe since last week, or last year in the U.S.”
Just over a month since S&P imposed ratings warnings on 15 euro nations, the company said Jan. 13 that it was downgrading nine countries after concluding recent policy steps may prove “insufficient” to contain a fiscal crisis now in its third year. Germany was left as the euro-area’s only stable AAA.
The fallout in financial markets has been muted. Spain yesterday paid an average 2.049 percent to sell 12-month debt, compared with 4.05 percent on Dec. 13. The previous day, France auctioned 1.895 billion euros of one-year notes at a yield of 0.406 percent, down from 0.454 percent on Jan. 9.
Like the U.S., France was downgraded one step to AA+ from AAA. Since September, French bonds have lost 1.56 percent, compared with a 1.73 percent gain for Germany, Bank of America Merrill Lynch indexes show. It costs more to insure the debt of France than South Africa and the Philippines, according to data from CMA, and the euro is down 4.8 percent versus the dollar.
Investors anticipated S&P’s action, said David Shairp, a global strategist at JPMorgan Asset Management in London. “While it is a blow to national pride, the implications of these downgrades may be limited since these moves were carefully signaled in advance. Indeed, a downgrade to the French rating was already reflected in the spreads.”
‘Worse’ Than Reality
The moves were “a case of your fears being worse than the reality,” said Steven Bell, a former U.K. Treasury official who is now chief economist at hedge fund GLC Ltd. in London. “The reality is that the European situation is improving massively,” with the ECB lending facility being “a massive game changer,” he said.
In downgrading France and the other nations, S&P cited the inability of government leaders to find a solution to reducing the region’s debt, saying “the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those euro-zone sovereigns subjected to heightened market pressures.”
“Politics are relevant with a small p,” Bell said. “One of the key points S&P have made is that you need a functioning political process to solve these problems.”
S&P, a unit of McGraw-Hill Cos. (MHP), blamed “uncertainty” in U.S. policy making Aug. 5 when it cut the assessment of the government’s ability to pay its debt, citing Congress’s failure to agree on as much long-term deficit reduction as the credit- rating company wanted. Warren Buffett, the world’s most successful investor, said S&P erred and the U.S. should be rated “quadruple-A.”
Investors often look to sources other than ratings companies for insights on the value of bonds, said Robin Marshall, director of fixed income at Smith & Williamson Investment Management in London. “Most investors do their own due diligence rather than relying on rating agencies alone. Look at the U.S. Treasury yields that have not stopped falling since it lost its top rating.”
For now, S&P is standing alone, as Moody’s Investors Service and Fitch Ratings haven’t changed their grades. David Riley, head of the sovereign-debt unit at Fitch, said Jan. 10 that France probably will retain its credit rating this year unless Europe’s fiscal crisis worsens.
Investors also may be taking their cue from more positive events, such as the ECB’s December loan to 523 banks of 489 billion euros for three years, said Joost van Leenders, a strategist at BNP Paribas Investment Partners in Amsterdam, who helps oversee about $780 billion.
Under terms of that operation, banks can borrow the money from the ECB at 1 percent and use it to buy bonds at debt auctions. Signs that the euro-region’s economy may have stopped deteriorating also may be helping to drive bond sales, with the ZEW Center for European Economic Research yesterday reporting German investor confidence jumped the most on record in January.
“The expansion of the ECB support here is really the critical issue,” said Jeffrey Rosenberg, chief investment strategist for fixed income at New York-based BlackRock Inc., the world’s biggest money manager. “The ECB with its funding support is reducing the risk of bank failure. Systemic risk overall is reduced in an environment of greater ECB support. The impact of a downgrade isn’t as dire as it might otherwise be.”
Calming the Debate
S&P might have erred in downgrading Europe’s bailout fund, said Lutz Karpowitz, senior currency strategist at Commerzbank AG in Frankfurt. The European Financial Stability Facility has liabilities of only 21 billion euros, so it still can issue “quite a few bonds without exceeding its AAA guarantee volume,” he said. “This more-than-remarkable approach on the part of S&P is not going to contribute to the debate surrounding the rating agencies calming down.”
John Piecuch, an S&P spokesman, declined to comment.
While German Chancellor Angela Merkel said the S&P announcement validated her push for tougher budget discipline, other policy makers either are playing it down or suggesting it be ignored. French President Nicolas Sarkozy called the French shift a nonevent that “changes nothing.”
German Foreign Minister Guido Westerwelle said yesterday it’s “high time” to create a European company to compete with established U.S. raters.
‘Pay Less Attention’
ECB President Mario Draghi questioned the importance of the companies on Jan. 16 and suggested “we should learn to do without ratings, or at least we should learn to assess creditworthiness.” Bank of England Governor Mervyn King said yesterday that “markets have gone some way towards that where they pay less attention to the rating agencies.”
The concern has been “primarily in terms of their competence and in terms of their pro-cyclicality,” King said. “They got carried away themselves by the hubris surrounding the financial sector before the crisis, and once the crisis has hit, they rush in to be the first to downgrade and then create a pro- cyclical process.”
Investors showed no reluctance to lend to the U.S. after S&P stripped the country of its AAA rating. While the Aug. 5 downgrade set off a 6.7 percent decline in the S&P 500 stock index the next trading day, the yield on 10-year Treasuries was still just 1.86 percent yesterday. Investors bid a record $3.04 for each dollar of the $2.14 trillion of Treasury notes and bonds sold last year, according to data compiled by Bloomberg.
Ten-year yields for the nine nations that lost their AAA status between 1998 and the U.S. downgrade rose an average of two basis points the next week, according to JPMorgan Chase & Co. research.
History suggests that a rally following a downgrade isn’t unusual. After S&P cut Japan in February 2001 to AA+ from AAA, 10-year bond yields fell below 1.15 percent four months later from 1.46 percent. Yields were at 0.961 percent on Jan. 17, even though S&P ultimately reduced the nation to AA-. Moody’s waited until May 2009 to lower Japan’s foreign-currency rating from Aaa, and now has it at Aa3, the same as S&P.
None of the 17 euro countries can print its own money, unlike the U.S., making it easier for the world’s largest economy to pay its debts. Fighting the credit crisis also sometimes requires the support of all 27 European Union members, slowing decision-making and leading to ideological rifts.
While some funds are required to hold debt with certain ratings, few will be forced to sell French debt as a result of the downgrade, Nikolaos Panigirtzoglou, a JPMorgan analyst in London, wrote in a Dec. 9 report. About 160 billion euros of the country’s 940 billion euros in bonds are held by non-European banks, insurance companies and pension funds that may opt to scale back their investments, he wrote.
The rating cuts still could trigger some forced selling by investors who are required to hold only the highest-quality securities in their portfolios, said Pacific Investment Management Co.’s Bill Gross.
“There are regulatory issues in the case of structures that are dependent on certain types of ratings; and to the extent that various countries get downgraded, then those positions have to be reduced, if only because of regulation,” Gross, manager of the world’s biggest bond fund, said in a Jan. 17 radio interview on “Bloomberg Surveillance” with Tom Keene and Ken Prewitt.
Nations have proved adept at skirting these rules, said Noel Hebert, a credit strategist at Mitsubishi UFJ Securities USA Inc. in New York. U.S. funds largely avoided selling Treasuries, and the ECB is likely to keep its rules flexible.
“Between the government basically calling the agencies idiots, changing accounting treatments as need be and arguing that everything is baked in, in sovereigns at least their role looks to be getting increasingly marginalized,” he said. “Life is easier if you just close your eyes and pretend the bad stuff isn’t happening.”